Heartland Financial USA, Inc. Reports Fourth Quarter 2012 Results

Heartland Financial USA, Inc. Reports Fourth Quarter 2012 Results

Quarterly Highlights

• Net income of $8.9 million or $0.50 per diluted common share

• Net interest margin of 3.81%

• Deposit growth of $342.6 million since September 30, 2012

• Merger with First Shares, Inc. completed on November 16, 2012

• Acquisition of Heritage Bank, N.A. completed on December 7, 2012

• Special cash dividend of $0.10 per share paid on December 28, 2012

DUBUQUE, Iowa--(BUSINESS WIRE)-- Heartland Financial USA, Inc. (NAS: HTLF) :

Heartland Financial USA, Inc. (Nasdaq: HTLF) today reported net income of $8.9 million for the quarter ended December 31, 2012, an increase of $2.7 million or 43 percent from the $6.2 million recorded for the fourth quarter of 2011. Net income available to common stockholders was $8.4 million, or $0.50 per diluted common share, for the quarter ended December 31, 2012, compared to $5.2 million, or $0.31 per diluted common share, for the fourth quarter of 2011. Return on average common equity was 10.59 percent and return on average assets was 0.71 percent for the fourth quarter of 2012, compared to 7.77 percent and 0.49 percent, respectively, for the same quarter in 2011.

Net income recorded for 2012 was a record $49.3 million, compared to $28.0 million recorded during 2011, an increase of $21.3 million or 76 percent. Net income available to common stockholders was $45.8 million, or $2.73 per diluted common share, for 2012, compared to $20.4 million, or $1.23 per diluted common share, earned during 2011. Return on average common equity was 15.59 percent and return on average assets was 1.03 percent for 2012, compared to 7.77 percent and 0.50 percent, respectively, for 2011.

The factors contributing most significantly to the increased earnings on both a quarterly and annual basis in 2012 compared to 2011 were the continued expansion of mortgage operations, coupled with reduced provision for loan and lease losses and increased net interest income.

On November 16, 2012, Heartland completed the purchase of First Shares, Inc. headquartered in Platteville, Wisconsin. Simultaneous with closing of the transaction, First National Bank of Platteville was merged into Heartland's Wisconsin Bank & Trust subsidiary. The merger expanded the number of Wisconsin Bank & Trust locations from seven to ten and added three communities in southwestern Wisconsin to the bank's service area. The transaction included, at fair value, assets of $128.0 million, loans of $84.9 million and deposits of $114.2 million.

On December 7, 2012, Heartland completed the purchase of Heritage Bank, N.A. located in Phoenix, Arizona. Heritage Bank, N.A. will operate as a separate charter until late in the first quarter of 2013 when Heartland expects to combine it with our Arizona Bank & Trust subsidiary. The transaction included, at fair value, assets of $109.1 million, loans of $63.4 million and deposits of $83.3 million.

Commenting on Heartland's results for 2012, Lynn B. Fuller, Heartland's chairman, president and chief executive officer said, "We are delighted to report that 2012 was an extraordinary year for Heartland by nearly every measure. Net income increased by 76 percent over 2011, with earnings per share growing by 122 percent."

Net Interest Margin Percentage Remains Stable; Increases in Dollars

Net interest margin, expressed as a percentage of average earning assets, was 3.81 percent during the fourth quarter of 2012 compared to 3.84 percent for the third quarter of 2012 and 4.08 percent for the fourth quarter of 2011. On an annual basis, net interest margin was 3.98 percent during 2012 and 4.16 percent during 2011. These declines are a result of the sustained low interest rate environment where yields on the securities and loan portfolios are declining at a greater pace than rates paid on deposits and other borrowings.

Fuller said, "Compared to the previous quarter, we are pleased to see net interest margin hold relatively steady at 3.81 percent in the fourth quarter. Going forward, we view margin as a key challenge in this low rate environment. Deposit rates have little room for further reductions while competition for new loans and lower reinvestment rates on maturing securities continues to push asset yields lower."

On a tax-equivalent basis, interest income in the fourth quarter of 2012 was $49.5 million compared to $49.3 million in the fourth quarter of 2011. On an annual basis, interest income on a tax-equivalent basis was $196.7 million in 2012 compared to $197.7 million in 2011. The small increase in interest income in the fourth quarter of 2012, as compared to the fourth quarter of 2011, was due to an increase in average earning assets, as the interest rate earned on those assets continued to decline throughout 2012 due to the sustained low interest rate environment. The average interest rate earned on total earning assets was 4.72 percent during the fourth quarter of 2012 compared to 5.22 percent during the fourth quarter of 2011. For the year, the average interest rate earned on total earning assets was 4.97 percent during 2012 compared to 5.43 percent during 2011. The most significant contributor to these declines was the overall yield earned on the securities portfolio, which decreased 67 basis points during the quarter ended December 31, 2012, compared to the same quarter in 2011 and 72 basis points during the year 2012, compared to the year 2011. Average earning assets increased $421.9 million or 11 percent during the fourth quarter of 2012 compared to the fourth quarter of 2011, with approximately $135.0 million attributable to acquisitions. For the year, average earning assets grew $322.3 million or 9 percent, with approximately $45.0 million attributable to acquisitions.

Interest expense for the fourth quarter of 2012 was $9.5 million, a decrease of $1.3 million or 12 percent from $10.8 million in the fourth quarter of 2011. On an annual basis, interest expense decreased $7.2 million or 15 percent. Even though average interest bearing liabilities increased $263.6 million or 9 percent for the quarter ended December 31, 2012, as compared to the same quarter in 2011, and $175.8 million or 6 percent for the annual period ended on December 31, 2012, as compared to 2011, the average interest rate paid on Heartland's deposits and borrowings declined 26 basis points during the quarterly periods under comparison and 30 basis points during the annual periods under comparison. Contributing to this improvement in interest expense was a change in the mix of deposits. Average savings balances, the lowest cost interest-bearing deposits, as a percentage of total average interest bearing deposits was 69 percent during both the fourth quarter and year in 2012, compared to 67 percent for the fourth quarter of 2011 and 65 percent for the year of 2011. Additionally, the average interest rate paid on savings deposits was 0.35 percent during the fourth quarter of 2012 and 0.38 percent during the full year of 2012 compared to 0.47 percent during the fourth quarter of 2011 and 0.57 percent during the full year of 2011.

Net interest income on a tax-equivalent basis totaled $40.0 million during the fourth quarter of 2012, an increase of $1.5 million or 4 percent from the $38.5 million recorded during the fourth quarter of 2011. For the year, net interest income on a tax-equivalent basis was $157.5 million during 2012, an increase of $6.2 million or 4 percent from the $151.3 million recorded during 2011.

Noninterest Income and Noninterest Expense Increase

Noninterest income during the fourth quarter of 2012 was $27.2 million, an increase of $8.2 million or 43 percent over the $19.0 million recorded during the fourth quarter of 2011. For the year, noninterest income was $108.7 million in 2012 compared to $59.6 million in 2011, an increase of $49.1 million or 82 percent. The categories contributing most significantly to the improvement in noninterest income during both comparative periods were gains on sale of loans, which increased $8.8 million or 160 percent for the quarterly comparative period and $37.8 million or 333 percent for the annual comparative period, and loan servicing income, which increased $1.5 million or 73 percent, for the quarterly comparative period and $5.4 million or 90 percent for the annual comparative period. For the quarterly comparative period, a portion of these increases was offset by a decrease in securities gains, which were $4.2 million in the fourth quarter of 2011 compared to a loss of $108,000 during the fourth quarter of 2012.

Loan servicing income increased $1.5 million or 73 percent for the fourth quarter of 2012 as compared to the fourth quarter of 2011 and $5.4 million or 90 percent for 2012 compared to 2011. Two components of loan servicing income, mortgage servicing rights and amortization of mortgage servicing rights, are dependent upon the level of loans Heartland originates and sells into the secondary market, which in turn is highly influenced by market interest rates for home mortgage loans. Mortgage servicing rights income was $3.5 million during the fourth quarter of 2012 compared to $1.4 million during the fourth quarter of 2011 and amortization of mortgage servicing rights was $1.9 million during the fourth quarter of 2012 compared to $862,000 during the fourth quarter of 2011. For the year, mortgage servicing rights income was $11.5 million during 2012 compared to $3.7 million during 2011 and amortization of mortgage servicing rights was $6.6 million during 2012 compared to $3.6 million during 2011. Loan servicing income also includes the fees collected for the servicing of mortgage loans for others, which is dependent upon the aggregate outstanding balance of these loans, rather than quarterly production and sale of mortgage loans. Fees collected for the servicing of mortgage loans for others were $1.3 million during the fourth quarter of 2012 compared to $932,000 during the fourth quarter of 2011. For the year, fees collected for the servicing of mortgage loans for others were $4.4 million during 2012 compared to $3.6 million during 2011. The portfolio of mortgage loans serviced for others by Heartland totaled $2.20 billion at December 31, 2012, compared to $1.54 billion at December 31, 2011. Heartland believes long term success in the mortgage banking business will depend on its ability to shift toward originations of loans for the purchase of homes, which will drive revenue when the refinance boom comes to an end. For the fourth quarter of 2012, refinancing activity represented 71 percent of total mortgage originations compared to 64 percent during the third quarter and 58 percent during the second quarter of 2012.

Gains on sale of loans totaled $14.3 million during the fourth quarter of 2012 compared to $5.5 million during the fourth quarter of 2011 and $13.8 million during the third quarter of 2012. For the year, gains on sale of loans totaled $49.2 million during 2012 compared to $11.4 million during 2011. The volume of loans sold totaled $478.3 million during the fourth quarter of 2012, more than double the $208.5 million sold during the fourth quarter of 2011. For the year, the volume of loans sold totaled $1.53 billion during 2012 compared to $452.9 million during 2011. Pricing received on the sale of fixed rate residential mortgage loans into the secondary market improved through a bulk delivery method that was implemented during the second quarter of 2011, instead of an individual delivery method that had been used previously. At the same time, secondary market pricing began to be matched with origination pricing through the use of a software tool that assists in hedging the locked rate pipeline position. Beginning in the fourth quarter of 2012, Heartland began the pooling of certain newly originated mortgage loans into mortgage-backed securities prior to delivery into the secondary market.

The following table summarizes Heartland's residential mortgage loan activity during the most recent five quarters:

For the fourth quarter of 2012, noninterest expense totaled $49.3 million, an increase of $9.1 million or 23 percent from the same quarter of 2011. For the year, noninterest expense totaled $178.1 million in 2012 compared to $137.3 million in 2011, a $40.8 million or 30 percent increase. Contributing to these increases in noninterest expense were a $7.1 million or 32 percent increase in salaries and employee benefits for the quarter and a $30.2 million or 40 percent increase for the year, a large portion of which resulted from the expansion of residential loan origination and the addition of personnel in the Heartland Mortgage and National Residential Mortgage unit. Commission expense was $5.9 million during the fourth quarter of 2012 compared to $3.5 million during the fourth quarter of 2011. For the yearly comparative period, commission expense totaled $19.8 million during 2012 and $6.8 million during 2011. The increases in commission expense are a direct result of the increased mortgage loan origination activity. Additionally, the accrual for incentive plan compensation payouts was significantly higher in 2012, in direct correlation with the higher period to date earnings and the reinstatement of incentive compensation for Heartland's executive officers after the repayment of TARP (Troubled Asset Relief Program) funds. Full-time equivalent employees totaled 1,498 on December 31, 2012, compared to 1,195 on December 31, 2011.

Fuller commented, "The Heartland Mortgage and National Residential unit contributed significantly to our extraordinary year with loan originations of $1.6 billion. Reflecting this fact, gains on sale of loans increased fourfold over the previous year. We continue to build on the capabilities of this business line with the addition of new sales personnel, new residential loan products and new technologies."

Heartland's effective tax rate was 32.07 percent for 2012 compared to 26.89 percent for 2011. Federal low-income housing tax credits included in Heartland's effective tax rate totaled $798,000 during both 2012 and 2011. Heartland's effective tax rate is also affected by the level of tax-exempt interest income which, as a percentage of pre-tax income, was 18.94 percent during 2012 compared to 28.78 percent during 2011. The tax-equivalent adjustment for this tax-exempt interest income was $7.4 million during 2012 compared to $5.9 million during 2011.

Net Loan Growth Continued at a Slower Pace; Strong Deposit Growth

Total assets were $4.98 billion at December 31, 2012, an increase of $679.5 million or 16 percent since December 31, 2011, with $391.4 million of this growth occurring in the fourth quarter, $165.5 million in the third quarter, $114.8 million in the second quarter and $7.8 million in the first quarter. Included in the asset growth for the fourth quarter of 2012 were the $128.0 million in assets acquired in the First Shares, Inc. transaction and $109.1 million acquired in the Heritage Bank acquisition. The asset growth for the third quarter of 2012 included $53.5 million in assets acquired from Liberty Bank, FSB. Securities represented 31 percent of total assets at both December 31, 2012 and 2011.

Total loans and leases held to maturity were $2.82 billion at December 31, 2012, compared to $2.48 billion at year-end 2011, an increase of $340.3 million or 14 percent, with $173.6 million occurring during the fourth quarter, $18.4 million during the third quarter, $97.2 million during the second quarter and $51.1 million during the first quarter. Included in the loan growth for the fourth quarter of 2012 were $84.9 million in loans acquired in the First Shares, Inc. acquisition and $63.4 million acquired in the Heritage Bank acquisition. Loan growth for the third quarter of 2012 included $9.4 million in loans acquired from Liberty Bank, FSB. Excluding acquisitions, loan growth for the year totaled $182.6 million or 7 percent. Commercial and commercial real estate loans, which totaled $2.00 billion at December 31, 2012, increased $191.9 million or 11 percent since year-end 2011, with $83.7 million attributable to the acquisitions. Residential mortgage loans, which totaled $249.7 million at December 31, 2012, increased $55.3 million or 28 percent since year-end 2011, with $26.3 million attributable to acquisitions. Agricultural and agricultural real estate loans, which totaled $328.3 million at December 31, 2012, increased $65.3 million or 25 percent since year-end 2011, with $37.7 million of this growth attributable to the acquisitions. Consumer loans, which totaled $245.7 million at December 31, 2012, increased $25.6 million or 12 percent since year-end 2011, with $10.1 million of the growth attributable to acquisitions.

"Even though organic loan growth of $183 million was short of our expectations, we continue to seek growth in quality loans rather than quantity." added Fuller.

Fuller also noted, "Our participation in the Small Business Lending Fund provides added incentive for the Heartland member banks to originate small business loans. As a result of our success in growing qualifying loans, we are realizing a lower capital cost of 2 percent on our $81.7 million of SBLF preferred stock. Consistent with our business purpose, the SBLF allows Heartland to provide affordable credit to small commercial and agricultural clients, which in turn helps to increase employment and assist the economic recovery in the communities we serve."

Total deposits were $3.85 billion at December 31, 2012, compared to $3.21 billion at year-end 2011, an increase of $635.5 million or 20 percent, with $342.6 million occurring during the fourth quarter, $168.1 million during the third quarter, $59.2 million during the second quarter and $65.6 million during the first quarter. Included in deposit growth during the fourth quarter of 2012 were $114.2 million in deposits acquired in the First Shares, Inc. acquisition and $83.3 million acquired in the Heritage Bank acquisition. Deposit growth for the third quarter of 2012 included $53.8 million in deposits acquired from Liberty Bank, FSB. Exclusive of these acquisitions, deposit growth during the year was $384.2 million or 12 percent. The composition of Heartland's deposits continues to improve as no-cost demand deposits as a percentage of total deposits was 25 percent at December 31, 2012, compared to 23 percent at year-end 2011. Demand deposits increased $236.9 million or 32 percent since year-end 2011, with $60.7 million of this growth attributable to acquisitions. Savings deposits increased $326.3 million or 19 percent since December 31, 2011, with $84.5 million of this growth attributable to acquisitions. Certificates of deposit increased $72.4 million or 9 percent since year-end 2011, with $106.1 million attributable to acquisitions and the offsetting decrease a result of more emphasis on growing the customer base in non-maturity deposit products instead of higher-cost certificates of deposit. As a percentage of total deposits, certificates of deposit were 23 percent at December 31, 2012.

Fuller said, "We continue to experience excellent deposit growth in most Heartland markets. Excluding acquisitions, deposits increased by $384 million, or 12 percent over year-end 2011. We continue to see a very favorable shift in our deposit mix through the growth of demand deposits which now represent 25 percent of our deposits."

Provision for Loan Losses and Nonperforming Assets Continue at Lower Levels

Exclusive of loans covered under loss sharing agreements, the allowance for loan and lease losses at December 31, 2012, was 1.37 percent of loans and leases and 89.71 percent of nonperforming loans compared to 1.48 percent of loans and leases and 64.09 percent of nonperforming loans at December 31, 2011. The provision for loan losses was $3.4 million for the fourth quarter of 2012 compared to $7.8 million for the fourth quarter of 2011, a $4.4 million or 57 percent decrease. For the year, the provision for loan losses was $8.2 million during 2012 compared to $29.4 million during 2011, a $21.2 million or 72 percent decrease. A reduction in the level of the allowance for loan and lease losses maintained for impaired loans was the primary contributor to the lower provision during 2012. The portion of the allowance for loan and lease losses maintained for impaired loans was $4.6 million at December 31, 2012, leaving the allowance on non-impaired loans, exclusive of acquisitions, relatively stable at 1.32 percent of loans and leases at December 31, 2012, compared to 1.31 percent at December 31, 2011.

Nonperforming loans, exclusive of those covered under loss sharing agreements, were $43.2 million or 1.53 percent of total loans and leases at December 31, 2012, compared to $57.4 million or 2.31 percent of total loans and leases at December 31, 2011. Approximately 53 percent, or $22.9 million, of Heartland's nonperforming loans have individual loan balances exceeding $1.0 million. These nonperforming loans, to an aggregate of 12 borrowers, are comprised of $7.3 originated by New Mexico Bank & Trust, $5.8 million originated by Rocky Mountain Bank, $4.5 million originated by Galena State Bank & Trust Co., $2.7 million originated by Wisconsin Bank & Trust, $1.4 million originated by Riverside Community Bank and $1.2 million originated by Arizona Bank & Trust. The portion of Heartland's nonperforming loans covered by government guarantees was $1.7 million at December 31, 2012. As identified using the North American Industry Classification System (NAICS), $12.4 million of nonperforming loans with individual balances exceeding $1.0 million were for construction/land subdivision and the remaining $10.5 million distributed among seven other industry categories.

Delinquencies in each of the loan portfolios continue to be relatively stable and no significant adverse trends were identified during the fourth quarter of 2012. Loans delinquent 30 to 89 days were 0.32 percent of total loans at December 31, 2012, compared to 0.53 percent at September 30, 2012, 0.46 percent at June 30, 2012, 0.55 percent at March 31, 2012, and 0.23 percent at December 31, 2011.

Other real estate owned was $35.8 million at December 31, 2012, compared to $36.1 million at September 30, 2012, $37.9 million at June 30, 2012, $38.9 million at March 31, 2012, and $44.4 million at December 31, 2011. Liquidation strategies have been identified for all the assets held in other real estate owned. Management continues to market these properties through an orderly liquidation process instead of a quick liquidation process in order to avoid discounts greater than the projected carrying costs. During 2012, $7.0 million of other real estate owned was sold during the fourth quarter, $4.2 million during the third quarter, $5.9 million during the second quarter and $12.4 million during the first quarter.

The schedules below summarize the changes in Heartland's nonperforming assets, including those covered by loss share agreements, during the fourth quarter of 2012 and the year: